Construction contract: Types, components, and best practices

A well-drafted construction contract is key to project success, as it sets out the terms, obligations, and expectations for everyone involved. It ensures clarity and provides legal protection, helping you manage risks and avoid disputes. Understanding the various contract types and their key elements is crucial for contractors, clients, and stakeholders alike.

Learn about the most common construction contract types, what makes a good contract, and how to manage them well. We'll also address some frequently asked questions to help you confidently navigate the complexities of construction contracts.

Understanding construction contracts

Construction contract documents detail all aspects of the project and guide you through each phase as you progress. They include the contract for construction work, detailed drawings, and specifications for construction. These documents serve as the roadmap, ensuring everyone—from the contractor to the client—understands the expectations. 

Just like construction accounting, construction contract documents are important since they: 

• Define the scope, cost, and schedule of your project. 
• Prevent misunderstandings by clearly outlining the roles and responsibilities of each party involved. 
• Ensure a smoother process, fewer disputes, and a clearer path to project completion.

You should also explore construction job costing to improve profitability and information on how to manage your construction contracts using an ERP solution.

Key construction contract terms to know

• Scope of work: A detailed description of the work to be completed, including tasks, responsibilities, and deliverables, ensuring all parties understand their obligations
• Addenda: Updates or changes made to the original contract documents before the project starts, ensuring all parties are aware of any revisions to plans or specifications
• Change order request (COR): Documents changes needed during the project, whether due to unforeseen issues or client requests, potentially affecting scope, cost, and timeline
• Retainage: A percentage of the contract payment withheld until project completion, serving as a financial incentive to ensure work is finished to satisfaction
• Field order: Addresses minor changes or on-site instructions that require quick implementation without significantly altering the project’s overall scope
• Liquidated damages: A set amount of money that the contractor must pay if the project isn't finished by the agreed-upon deadline. This will compensate the client for delays.

Key construction contract types

Choosing the right type of construction contract agreement can make all the difference. It involves understanding different parts of a contract that define how costs are managed and responsibilities are assigned. Here, we explore the main contract types, highlighting their features, benefits, and potential drawbacks to help you make an informed decision for your project.

1. Cost-plus

A cost-plus contract covers the contractor’s actual project expenses plus a profit margin, which may be either a fixed sum or a percentage of the total costs. It provides flexibility for projects where the scope may change or unforeseen issues might arise.

This type of contract offers transparency and flexibility, making it easier to manage changes and unexpected conditions. However, the lack of a fixed total can lead to higher costs and less certainty about the final price. Proper construction inventory management is key to avoiding cost overruns.

2. Design-build

In a design-build contract, one entity is responsible for both the design and construction of the project. This integrated approach can help streamline communication and speed up the project timeline, as design and construction phases overlap.

The design-build method simplifies project management by providing a single point of contact and often results in faster completion. That said, it may limit your control over the design process and can potentially lead to higher initial costs due to the integrated approach.

3. Guaranteed maximum price

A guaranteed maximum price (GMP) contract limits the total project cost. The client agrees to pay the contractor up to this maximum amount, and any savings below this limit are typically shared between the client and contractor.

The GMP contract offers cost control with a fixed upper limit, encouraging the contractor to complete the project under budget. However, it might include a higher initial price to cover potential risks and can complicate the process of managing scope changes.

4. Incentive construction

Incentive construction contracts provide additional compensation to the contractor for achieving specific goals, such as completing the project ahead of schedule or under budget.

These contracts encourage high-performance and cost-effective solutions, potentially leading to savings. On the downside, disputes may arise over goal achievement criteria, and the contract may lead to higher initial costs due to the incentive structure.

Check out our construction accounting software, which offers process automation, better tracking, and deeper insights. 

5. Integrated project delivery contract

Integrated project delivery (IPD) contracts involve all major project stakeholders—owner, architect, and contractor—in a single collaborative team. They aim to align interests and share risks and rewards among the participants.

IPD contracts foster collaboration and innovation, leading to more efficient processes and better outcomes. However, setting up and managing an IPD contract can be complex, and disagreements among team members may pose challenges.

6. Lump-sum contract

A lump-sum, or fixed-price, contract involves the contractor completing the project for a predetermined total amount. It includes all costs related to labor, materials, and overhead.

With this contract, you get cost certainty and simplified budgeting, as the total price is agreed upon upfront, but it provides less flexibility for changes. Also, a fixed budget might lead a contractor to cut corners, potentially compromising the quality of the work.

7. Time and materials contract

In a time and materials contract, the client pays for the actual time spent on the project and the cost of materials used. It’s a good choice for projects with uncertain or evolving requirements.

Though the time and materials contract provides flexibility and transparency, allowing you to adjust the project as needed, it can lead to uncertain final costs and potential inefficiencies.

8. Unit price contract

A unit price contract sets the price based on the unit of work, such as square footage or linear feet. The final cost is determined by the actual quantities of work performed.

This contract type is ideal for projects with variable quantities, providing a clear pricing structure, but fluctuating quantities can lead to unpredictable final costs. Also, discrepancies in measurements can lead to disputes over payments.

9 essential construction contract elements

A well-crafted construction contract agreement details every aspect of the agreement, from scope and specifications to timelines and costs. Here are the nine essential elements of a construction contract to ensure you understand what should be included and what role each component plays in ensuring a smooth and successful construction process.

1. The agreement

The agreement outlines the fundamental terms and conditions of the contract, including the project scope, cost, and timelines. It serves as the foundational document that details the obligations and expectations of both parties involved in the construction project.

2. General conditions

General conditions are standard provisions applicable to most construction projects. They cover the basic rules and responsibilities, such as project management, safety requirements, and legal obligations, ensuring consistency and clarity throughout the project.

3. Special conditions

Special conditions address specific requirements unique to the project, helping you tailor the contract to your business’s needs, such as site constraints or specialized work. These also include additional details beyond the general conditions to accommodate unique project demands.

4. Scope of work

The scope of work details the specific tasks and deliverables required for the project. It defines what is included in the project, outlining the work to be completed, any exclusions, and the standards for performance, ensuring all parties have a clear understanding of project expectations.

5. Construction drawings

Construction drawings are visual representations of the project, including floor plans, elevations, and sections. They provide a detailed guide for construction, showing how the project should be built and serving as a reference for both contractors and clients.

6. Specifications

Specifications outline the technical requirements and standards for materials and workmanship. They detail the quality and performance criteria for construction elements, ensuring that materials and work meet the necessary standards and project requirements.

7. The schedule

The project schedule provides a clear timeline, highlighting key milestones, deadlines, and the sequence of work tasks. This structure supports effective time management and progress tracking throughout the project. 

8. Schedule of values

The schedule of values breaks down the project costs into specific categories, such as labor, materials, and overhead. It provides a detailed account of the budget allocation and helps you manage expenses and track financial progress.

9. Bill of quantities

The bill of quantities is a detailed list of materials and labor required for the project. It includes quantities, descriptions, and unit prices, providing a comprehensive overview of the resources needed and helping to estimate project costs accurately.

Use a custom ERP with automation capabilities to manage your construction contracts with ease.

Best practices for managing contracts in construction 

Managing construction contracts effectively is crucial for project success. Here are some key strategies to help you manage your construction contracts efficiently and keep your projects on track.

Create a clear document hierarchy

Organizing construction documents in a clear hierarchy ensures easy access and reference throughout the project. A well-structured system helps you keep essential documents like contracts, drawings, and specifications readily available. It also avoids confusion and accounting mistakes while streamlining communication and decision-making.

Adopt a comprehensive document management system

Using a document management system simplifies the process of storing, managing, and sharing documents. Construction software tools allow you to track revisions, control access, and maintain a central location for all contract-related files, improving efficiency and reducing the risk of lost or outdated documents.

Keep documents current and comprehensive

Regularly updating your construction documents ensures accuracy and prevents potential disputes. Make sure all changes, additions, and clarifications are recorded, and verify that all documents are complete. Comprehensive records are key to ensuring compliance and maintaining transparency throughout the project.

Implement defined change order processes

By setting up a structured change order process, you can better manage any modifications to the contract. A clear procedure for submitting and approving changes ensures all parties understand the scope, cost, and timeline implications, reducing disputes and keeping the project on track.

After signing, reference the contract docs

Once the contract is signed, consider referring to the contract documents throughout the construction process. Doing so ensures everyone follows the agreed-upon terms, avoiding miscommunication and ensuring the project adheres to its original scope and conditions.

Navigate midsize and complex business challenges and opportunities

Running a midsize construction business comes with its fair share of challenges but also plenty of opportunities. Whether it’s managing contracts or keeping projects on track, having the right tools can make all the difference. 

Enterprise accounting software, like Intuit Enterprise Suite, can help make managing your construction business easier.